Ametek Deserves Its Premium

Ametek (NYSE:AME) is an odd, not-so-little industrial company. Although it produces over $3 billion a year in revenue, it's not widely followed by large investment banks (though it does have plenty of institutional ownership). It's also an unusual company in that management is content to focus on product innovation in niche businesses and stay concentrated on a component-oriented business model. While the shares are not especially cheap today, this looks like a classic example of a stock to put on a watch list in hopes of taking advantage of a future pullback.

Growing Into The Slowdown

Like the end markets it serves, Ametek is seeing growth slow as a result of the macroeconomic factors we've all been reading about for weeks and months now. Still, Ametek is more than holding its own with the likes of Emerson (NYSE:EMR), Danaher (NYSE:DHR), Dover (NYSE:DOV), and ABB (NYSE:ABB).

Revenue rose nearly 9% in the second quarter, with 11% growth in the Electronic Instruments Group (EIG) and 6% growth in the Electromechanical Group (EMG). Organic growth was basically flat, however, as the more cost-driven legacy motors business saw a sizable decline - outside of this, core business was up about 2%.

Ametek has long stood out for its ability to drive improvements in its margin structure, and this quarter was no exception. Operating income rose about 18% and Ametek saw a nearly two point improvement in operating margin.

Doing A Little Bit Of Everything, But Doing It Well

Ametek is a little tricky to monitor and model because it serves so many different end markets. For instance, sales to the aerospace and "general industrial" markets are about 15% of sales each, while oil/gas is the only other market that contributes more than 10% of sales. Other broadly considered markets like defense, medical, technology, and metals/mining all claim high single-digit shares of revenue.

Due in part to the fact that Ametek doesn't look to expand its business vertically and become a full OEM supplier, it often supplies multiple competitors in the same markets. Better still, it can often leverage the same sort of sensor/monitor technology into multiple markets. Consequently, products (or technologies) that the company can sell into the aerospace or metals space can also be sold into research labs or industrial companies as well.

As it does so many things, it's a little more difficult to come up with a real list of comparables. Like Emerson, ABB, and Siemens (SI), Ametek sells motion control products and motors. Like Honeywell (NYSE:HON), United Technologies (NYSE:UTX), and Eaton (NYSE:ETN), it also sells a variety of sensors, measurement devices, and instrumentation. Ametek doesn't attempt to compete by matching these much larger rivals in terms of product breadth or competing on price, but rather looks to create defensible and lucrative niches through superior engineering.

Leveraged To The M&A Market

Ametek has long been a company that has grown through acquisition, and there is no indication from management that this strategy is going to change soon. What Ametek does better than most, though, is identify small companies with quality products where Ametek can leverage better profitability through more efficient sourcing, manufacturing, and so on. Although they do run the risk of competing with other industrials and/or private equity groups for the same properties, management has a history of price discipline.

With about half of the company's sales coming from the U.S. today, it would not surprise me if the company starts to look for more overseas acquisitions. The company already has manufacturing facilities in Mexico, Brazil, and China, but there's still plenty of room for growth here in the future.

The Bottom Line

The only area where this stock falls down a bit for me is in the valuation. Ametek may not be a household name, but the valuation provides ample evidence that it's not an unknown name.

Projecting a decade's worth of 8% compound free cash flow growth isn't enough to generate an attractive price target on these shares. Instead, you have to go into the low teens (at a minimum) to see any real undervaluation. Now maybe that doesn't seem so aggressive against a history of low teens revenue growth and better than 20% free cash flow growth, but it does increase the scale of the challenge. If Ametek can find a way to push its free cash flow margin into the high teens, that sort of growth could happen, but for now I'd be content to wait on the hope that these shares pull back to a more reasonable valuation before buying.

Disclosure: I am long ABB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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